Why has consumption been so slow to recover?

John Cochrane has a very interesting post on this topic, here is one excerpt but it is quite wide-ranging:

New Keynesian models are a bit fuzzy on just why interest rates have to be so low — why the “natural rate” is sharply negative and why zero interest rates aren’t enough. Many of the formal models assume that consumer’s discount rate (rho) has declined sharply, beyond the capacity of the interest rate to follow it. If rho goes to, say -5%, with our 2% inflation, then even a zero nominal interest rate is like a 3% real interest rate. (These are deviations from trend, so one might not need actually negative discount rates to hit the zero bound. But even adding growth, it’s hard to avoid the need for a negative natural rate to cause a problem of this size.)

Now, a spontaneous outbreak of thrift, to the point of valuing the future a lot more than the present, seems a bit of a strained diagnosis for the fundamental trouble of the US economy.

To be fair, all the papers I’ve read say clearly that they regard the decline in the discount rate rho as a stand-in for some more complex process involving the financial crisis. For example, a more precise version of my first equation adds a “precautionary saving” term. When people are very uncertain about the future, they save more, just as if they had become much more patient. In equations,

[TC: see the equations in his original post, I don’t get them to reproduce]

This story seems possible for 2008 and 2009, in the depths of the financial crisis and recession. But I’m less convinced that it describes our current moment. Just look at the graph. Our state is one of steady but sclerotic growth, not one of great consumption volatility.

For my part, I get nervous when I read Keynesians claiming that the real rate of return is negative these days.  Is civilization moving backwards?  (And if so, don’t we really have a budgetary problem?)  I prefer instead to think about segmented rates of return and wonder why that has come about, and if so how we actually measure opportunity costs for projects.  If the risk premium on private projects is quite high, motivating a rush to T-Bills, is then the risk premium on government projects high or low?  Does “the chance that the government repays my loan,” as measured by bond rates, equal “actual comovement consumption risk of the government project itself”?  I see those two variables confused all the time.

Cochrane’s post is also very interesting on the differences between new and old Keynesianiam.


Many of your fears will be assuaged if you think of government bonds not as modes of government financing but as a key asset in a portfolio choice decision.

Unless we have reason to conclude that the level of debt is already too high, we have no way of judging whether we have a budgetary problem or not.

There is a world debt problem. People (may be) loaning to the government because they can tax and inflate, and thus provide greater assurance of return OF investment. So, one might say "well, then they are willing to accept that inflation rate" (and a higher taxation rate for me) but what if the people buying bonds are somehow divorced from the normal consequences and incentives that would face a rational individual?

People, meaning the Federal Reserve, or people, meaning banks taking their generously puffed up reserves and buying Treasuries. Or people, meaning banks looking to fit their asset portfolio to a regulatory regime that considers sovereign debt risk free allowing higher leverage.

The only reason that interest rates are so low is so that government can continue borrowing and refinancing. The rest of the economy be damned.

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Maybe the globe is falling in giant liquidity trap that Japanese and US bubbles the last thirty years have soaked-up. In terms of investment loans, it appears technology does not need to borrow (They spend out of cash) a lot money to grow their business and the factory investment is mostly done in China. Investors are having stagant returns based on the trickle up pain of stagant US and developed world wages.

Anyway, I believe China is just entering their Roaring 20s period of excess investment not at the end of it.

China is now Japan circa 1990,

I should worded it better but I think China is entering into Japan 1982 or US 1923. It is entering the era of great economic growth but way over-investment.

I got you. I just think China is a little closer to down turn than you do.

Ok, stop that! You guys are scaring me.

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Incredible! Do these academics ever think about the world around them, using, you know, their eyes?


Consumption sucks because the consumer is fucked and he knows it. Businesses know the consumer is fucked. After all, they are firing employees-consumers as fast as they can and/or paying him as little as they can. Somehow they must know what it means at the aggregated level. In a Game Theory sense, the first company who decided to stop paying living wages was the first to 'default'. It won. Now that all companies have 'defaulted' , what does Game Theory say about the outcome? Stable sub-optimum or somesuch?

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I agree the Cochrane's discussion of the models is useful. And any clever ideas to attack this question are most welcome. Personally, I am partial to the explanations in the permanent income section, which is not excerpted here. These were the three points that I posted (awaiting approval) on Cochrane's blog:

1. I think that models which rely on significant interest rate sensitivity by households are going to have a hard time explaining actual consumption. From both working with macro times series in a reduced form way and more structured micro data analyses, inter-temporal smoothing looks weak. Now interest rates are likely important for durable expenditures (not flow consumption) but that's more likely a user cost or maybe an expectations channel.

2. I think the permanent income explanation is more plausible, though I would not take such as dismal view of policy effectiveness. The resources available to households took a big hit in the recession, lower net worth, little income gains, high unemployment AND households appear to have projected those conditions forward. The income expectations series in the Michigan survey fell like a rock in the recession. (See the link for some charts: https://docs.google.com/file/d/0B3Xcr11DtXJ-OTE1ODRhYTktYzQ3NS00NGYwLWExYzEtNjlmNmJiNTI1NGEz/edit?pli=1). Some additional analysis I have done with that data suggests that household might have overshot...become too pessimistic following the recession about their income prospects. That excess pessimism has been pretty persistent, but that doesn't necessarily mean its impervious to policy. One could imagine it being an extra kick if the recovery got going.

3. One last thing to ponder: two areas of spending that have been particularly weak in the recovery are housing services and financial services. Of course, the first order problem is that everything has been weak in recovering, but it might tell us something about particular channels, such as from the housing market.

I'm partial to a combination of 2 and 3. The last Great Deleveraging in this country was in the 1930s and 1940s, and it set the stage for the astonishing growth right up through 2007. An ingredient of this growth was a gradual slackening of credit and a gradual leveraging of (increasing) household balance sheets. All of this prolly makes sense in a society that is becoming richer, but it provided basically a constant tail-wind to economic activity for more than half a century (e.g. in the 1950s, the novelty of a 3-year car loan was unveiled, and don't get me started on credit cards.)

But leveraging can be risky, and we went too far. Pre-housing bubble, a modest retrenchment in leveraging would have been fine, but after 9/11, costs were off the table in discussions of anything, The last chapter of recklessness was all in the housing market. And housing has lead every post-war recovery.

Isn't this exactly what deleveraging looks and feels like? Small steps to a much better world.

Brian wins again

Why did households lever up? Why are they levering down? Leverage amplifies shocks is not just a lesson of the Great Depression....hold generally on the upside and downside. Oh and what's the target leverage for households and do you have evidence they are 'actively' working toward that? And would that target depend on their income prospects and net worth?

Why did households lever up? Because they were getting richer.

Why are they levering down? Because they overdid it, increasing insolvency risk (lots of examples here.)

What's the target leverage for households? Depends on the household, but, for most, it's less than what it was in 2007, which was bolstered by inflated real estate prices for many.

Do you have evidence they are "actively" working toward that? Yes. The fact that many economists scream until they're blue in the face that people aren't spending enough- a "hair of the dog" cure if I've ever heard one. Seriously, though, there is lots of evidence on decreasing household leverage over the past four years (especially if you ignore our government debt tab, which I don't, which is one reason I'm not spending.)

And would that target depend on their income prospects and net worth? I hope so. As I said, increasing leverage as a society gets richer makes sense, we just went too far.

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"When we make plans for the future, those plans are almost certainly conditioned on our views about the future."

Indeed, we need to do a better job living up to the models, people!! Come on, get with the program, people!!

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Brian, my point is that leverage is an outcome variable just like spending. It would make no sense to say spending is weak because households are spending less. Why? It's the variables behind the debt, spending, and saving decisions that are important, imo and give us insight on the causal forces.

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"my point is that leverage is an outcome variable just like spending." Aha! Maybe this is a smoking gun. Because this is how economists think, and how they advise governments- everything is about flows, nothing is about stocks. And most of the time, this works fine, until the balance sheet gets too far out of whack. Throw in a pinch of "governments aren't households" and governments can keep the leveraging game running for longer, but not indefinitely.

"It would make no sense to say spending is weak because households are spending less." I'd say this makes as much sense as any tautology. But I don't think of leverage as merely an outcome variable. I believe people take their balance sheet into account when making decisions- maybe they didn't before 2008, and we've all learned a painful lesson, but to me, leverage is an input to the spending decision, so I don't see it as tautological.

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you are killing me. I think net worth, a stock, is very important. no one eats leverage...cake bought on credit maybe, but not leverage.

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OK, I'm trying not to be obtuse here.

Perhaps what I'm saying is that leverage affects net worth, which affects the spending decision. But this isn't quite right either. If I have $100,000 in assets and no liabilities, then I take out a $300,000 loan to buy a $300,000 house, my net worth is unaffected, but my financial situation is more precarious.

If Americans were less leveraged in 2007, they would have absorbed the popping of the real estate bubble without so many being wiped out. So, we learned a lesson about leverage, and its dangers, and how much more sensitive net worth is to a leveraged balance sheet than to an unleveraged one.

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Maybe the lesson was not the dangers of leverage (can be good too), but the dangers of overly optimistic house price forecasts...or optimistic income forecasts. Debt is not always bad, even in large amounts. It's not that easy to right down a model in which debt, above and beyond, net worth wealth matters. It's possible using collateral constraints but it can imply some odd behavior. Still a very active area of debate.

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Hey Claudia,

I really appreciate your thoughts here. Thank you.

If I may make a final comment, building off of your last comment:

I think you're exactly right- we were all too optimistic in 2007. Lack of experience with the downside of leverage led us to grossly underestimate the risks. So, when I look at a trend of AD up through 2007, I feel like that line was always unsustainable, we weren't as rich as we thought we were, and any "output gap" that starts from that line is gonna include significant exaggeration.

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Brian (and others), thank you for the comments. It's nice to hear some supporting ideas (and some push back) from real (non economist) people. Survey data can only 'talk' so much. Plus what a good, motivating start to my new research cycle...must write up my further analysis of income expectations. (Though probably means being quieter here. Win, win.)

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I like Frederic's earthy expression of #2, and I guess I feel it. I'm retired with a fair nest egg. I consume less than a 3 or 4 percent rule though, because I doubt future returns. If there is one of me, there are more ...

Yep, sorry for the swearwords but I feel this point is pretty obvious.

Claudia expresses it very well indeed and my question is how smart people like Dr. Cochrane can miss the obvious.

I am still struggling to formalise this even a tiny bit but let's put it this way. If I was building a macro model, interest rates would have very little to do with overall consumption. Even tax rates or profit margins are quite secondary. Growth drives growth. Consumers/workers need to see/feel/believe in income growth and companies need to see/fee/believe in revenue growth.

It's top line all the way as far as consumption/investment decisions are concerned.

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My (a bit less) earthy, non-economist version of the pessimism shock is: "we broke the American dream." Homes went from a being sign of 'making it' to a sign of stupidity. People borrowed to buy homes, to buy stuff, to educate their kids because they thought the economy, their income, their wealth would keep growing. True, these expectations proved overly optimistic but now they seem overly pessimistic. Maybe more direct and explicit support for 'Main Street' would have helped, but I do think stimulus provided some help and there are signs of gradual improvement with time, healing.

“we broke the American dream.”

Cochrane said something in the comments about what a great time it was to be a 29 year old given the low price of housing, stocks, etc. Something tells me he's not actually spending much time with 29 year olds.

I actually just went to the wedding of two 29 year olds. Both are very bright people with degrees (undergrad and grad) from great schools with pretty decent jobs. We talked at length about how they both had $200k in school loan debt ($400k as a couple), and how they can't imagine how they'll ever get out of that, much less save up the kind of money they'll need to avoid their children from having the same school debt burden, much less ever afford a house, much less saving for retirement on top of that.

Throw in their best guess about what will happen to health care costs by the time they're old (and how that will get paid for), and they're pretty resigned to the fact that financial prosperity will never be in the cards, and that keeping your head above water is about as good as it can get. Compared to many of their peers, they'll consider themselves very fortunate if they can pull that off. And that will only happen if consumption is kept to a bare minimum.

I have no idea how representative their view of the future is, but it's similar to what I hear from students. Talk of future productivity growth isn't much comfort either since median real wages haven't gone up with that productivity at any point in any of these people's lives. They don't expect that to change.

It does seem a bit odd to posit that now is a great time to be young in a discussion pertaining to an unexplainable drop in consumption and economic growth that might be permanent.

Student loans are not going to be a driver of consumption growth, are they?

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Claudia -

To pick up the thread from the previous post re the Fed and oil:

The economy is missing something like 0.7-1.2 percentage points of GDP growth, $100-150 bn, per annum. Where did it go? The economics community rather credulously accepted the Reinhart / Rogoff thesis that this must be associated with deleveraging, even though growth rates in the 1930's recovery averaged something like 7%.

But now, deleveraging as an explanation is losing some of its luster, as we're nearly four years post trough. So what else could it be? To reduce growth by such a large amount, it must be something visible. Consequently, there are really only two suspects: the deficit and oil.

If oil is the culprit, then that puts quite a different spin on the economic outlook. You can't stimulate your way out of that. So oil is one of the biggies, and it really changes your view of things if it is the culprit.

Now, you might think the Fed would then--just proactively--assign a couple of economists full time to get a handle on the issue. Has it done so? Not that I can see. You have Hale and Nechio (Aug. 2012), both of the SF Fed, with a workman like paper on oil and gas prices. Nice as it goes, but they rely excessively on papers published before the oil supply stalled in 2005. Look at their resumes: they're not oil specialists. Both are tourists.

Juvena and Petralla are both tourists. No depth at all on oil issues.

Luca Guerrieri of the DC Fed is not a disaster. He's working with Lutz Killian, who in the domestic pantheon of oil macro economists is No. 2 (behind Jim Hamilton, who has no peers). His work is way too formula laden, and no one's taught him how to write a punchy paper, but he could be a serious guy in the field with a bit of coaching.

And that's really all that pops up on Google.

All these folks are working on speculation and price shocks, which are way, way off the current topics in the field. Not one of them knows how to forecast demand or prices, or has any feel for supply. If I use terms like "carrying capacity", "inherent demand", and "elasticity toggling", these guys would have no idea what it's about. If I tell them that the key issue today is the pace of efficiency gains, not speculation, they're not going to get it.

So, the Fed is not really putting a lot of firepower into a topic that could be utterly central to its understanding of the economy and its forecasts. It really needs to try harder.

On the other hand, if I had a couple of weeks with that Luca guy, well, we might be able to do something with that.

There is a lot of analysis at the Fed that does not "pop up in Google." I can't give you a link to most of my consumption analysis and it's kept me too busy to crank out working papers. I am skeptical that oil is the missing link here...as it's already given a good bit of attention. That said, I plan to pass along an edited version of your comments to some relevant economists. Thanks.

And Steven, my frustration is not so much directed at you. It irks me that more of our work doesn't "pop up in Google." It's hard to get thoughtful feedback if people don't know what you're working on. Much of our current analysis does not lend itself to academic publications so it just does not come out. It does exist though. In any case, I am doing my part to try open up lines of communication. The link document was actually a mock up of a 'blog' post. Don't hold your breath, but you remind me why it's important to keep pushing that idea.

Well, it's alright to be a bit frustrated with me.

I am involved with oil markets all the time. I think oil explains a lot, but I don't see that reflected in many official institutions, including, but not limited to, the Fed.

The institutional work that's been done primarily revolves around i) supply-driven oil shocks, and ii) speculation. The latter to me is less interesting (although I believe I'm the only one to propose a non-financial cause of such speculation). As for price shocks, research has dealt almost exclusively with acute, rather than chronic, situations. Our situation right now is chronic, not acute. (Elasticity toggling is how you move from one mode to the other.)

No one, to the best of my knowledge, has looked at what happens to the economy if the Chinese bid away US oil consumption day after day, forcing us into continuous, dynamic adjustment. One potential result would be lower GDP growth, if oil is a binding constraint. Another potential outcome is a fall in productivity. Right now, any new hire in the US cannot use a drop more oil to drive or fly. Could that have an effect on productivity? I think it could.

It's quite important that the Fed properly understand this phenomenon. There's too much riding on it.

That's my frustration.

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I've never heard a convincing argument as to why fuel procurement issues affect the "West" only when it comes to economic growth.

Uffy -

You've hit the nail on the head.

So, when demand is increasing faster than supply, then oil consumption will be reallocated from the slow growing countries, the OECD, to the fast growing countries, the non-OECD. Thus, the price of oil will be set above the carrying capacity of the OECD, and below the carrying capacity of the non-OECD (which has a higher marginal utility of oil consumption). This lack of oil affects both OECD and non-OECD, but the effects on the OECD are more pernicious, because the OECD must actively reallocate economic activity away from incumbent uses. Thus, if the US must reduce oil consumption by 1.5% per year, then the status quo ante is unsustainable. If China's oil growth would like to be, say 8%, but it can only grow by 5%, then oil-related activities won't grow as quickly as otherwise, but incumbent activities are less likely to require liquidation, as oil consumption continues to grow there.

By the way, the overlap between oil donor countries and countries experiencing fiscal distress is pretty high.

This will be the subject of my Feb. 12th talk at Georgetown University.

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Thanks for a GREAT comment, Claudia.
I really believe in some Lifetime Income influence on consumption, and also on excesses of both optimism (going up) and pessimism.

The big big hit to Net Worth is seldom talked about clearly. "How much money do you have"? For most homeowners, not including home equity gives a hugely false answer. Equity was/is their "money in the bank, available for a rainy day".

With the house price bubble pop, they found out they had less money. And that growth would be lower, so they'd have a harder time to catch up -- and there's far fewer years before retirement.

When you're 40, looking to retire at 65, you have 25 years ... at 50, only 15 years ... at 60 only 5 years. Baby boomers are looking more at 60 than at 50, much less 40 (long ago). The demographics are against production growth more than before.

Finally, another under reported reason for low consumption, is the loss of illegals. Surely their prior off-the-books but real income usually translated into on the books store purchases and increased rental demand. The economic benefits to America of the illegals are seldom talked about, but are real and substantial, tho much less now than at house peak of 2005. (And the loss of illegal jobs first in construction is one reason the incomplete statistics didn't see the growing unemployment in 2006-2008. Not until the "crisis" when house buying speculators began to "realize" their houses were NOT going up in price enough to cover all their costs and give profits ...)

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My amateur take:

There is still a deleveraging of bad consumer debt going on (while governments cope with falling revenues budgetary pressure in a leveraging of their own)..triggered by deflationary pressure on bubbly assets that has been thwarted somewhat by monetary policy and fiscal policy. Think of heavy infusions of helium bags under increasing gravity. Bottom line, *the real price is always right* despite any efforts to maintain illusions for bubble prices.

What policies have done has been basically to reduce this downward pressure to slow trickle or flow rather than the swift and painful collapse that would have happened (and ended by now). But it cannot stop it. Economics, bored/dissatisfied with these basic observations and truths looks for more sophisticated ways to use its knowledge (See Cochrane article) to explain things and fight them on its chosen terms. What's more, equities investing has remained cheap because of all this QE infinity, which has given the stock market a somewhat artificial buoyancy these last few years.

While this is happening, baby boomers are consuming less. Boom, there it is. And there really is no answer for this. It's demographics. GenX < Baby Boomers. And it is GenX that is in the highest consumption phase at present. Boomers are winding down. Boomers had their time in the late 80s, 90s and 00's (wide group)....when increasing consumption couldn't be stopped. Coincidence? No.

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> For my part, I get nervous when I read Keynesians claiming that the real rate of return is negative these days. Is civilization moving backwards?

Couldn't this be a by-product of being at a low-demand equilibrium? The demand for savings (to use for investment) could be very low just because demand is low. If a firm's current stock of human and physical capital is sufficient to produce all that customers are demanding, why borrow? What little capital expenditures that are necessary to maintain adequate production capacity is likely payable out of cash reserves and profits (both very high right now on average).

A world with higher demand would require that firms contemplate increasing productive capacity, and therefore borrowing. Interest rates would rise back to where they "should" be: in positive territory.

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There is a relationship, you know, between consumption and income, unless you borrow.

In addition to deleveraging discussed above, you should look at consumption by income quintiles, rather than discussing consumption in the aggregate.

My observation is that consumption is just fine at the upper incomes, its just that this is a small part of the population relative to the rest of the population. And, for the upper income levels, they never leave the hedonic treadmill, nor do they stop competitive consumption, from my observation.

But, if you are lower income, what is there to consume, particularly if you borrowed too much?

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Waldman had an interesting recent post on inequality as a driver of underconsumption:

"Inequality is not unconditionally inconsistent with robust demand. But under current institutional arrangements, sustaining demand in the face of inequality requires ongoing borrowing by poorer households. As inequality increases and solvency declines, interest rates must fall or lending standards must be relaxed to engender the requisite borrowing."



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Our houses (if we have not been forclosed out of them) are worth less, we have less confidence in our income being sustained at it's current income, we have been burned by credit, we have little confidence in our government, we have discovered that our previous method of determining how much we can afford to spend (as long as we can make our monthly payments, we are good) is not very resilient, our needs have been artificially inflated by advertising, easy credit, overconfidence in growth, and our own greed.

I sometimes think that we are outsmarting ourselves.

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Something you left out of your quote from Cochrane was his explanation of why consumers might be worried about the future growth of their incomes. He listed their fears about the costs of Obamacare and Dodd-Frank, whereas there is little evidence of that, with businesses continuing to worry more about the future growth of demand for their productes. What would provide an explanation for this possibly expected slower future growth of income would none other than your Great Stagnation argument (along with Gordon's), which posits a slowdown of future significant technological change and productivity growth. Even though I do not know if that will happen or not, it seems a lot more plausible than the rather silly reference to Obamacare and Dodd-Frank that Cochrane pulls out of his hat.

Might the explanation be simpler? To what extent are future expectations simply an extrapolation of recent experience? Nowadays, people who buy a house take account of the possibility that the value of the house decreases. How many people considered this six years ago? Does it have anything to do with the fact that, six years ago, no one had been through an experience of a widespread decline in home values?

Same for income- the experience of the past six years looms large in our expectations.

The rear view mirror is not the best guide to forecasting, of course, but when we looked in the rear view mirror six years ago, it was all sunshine and unicorns, and that wasn't so good either, so I'm not sure if we've 'overcorrected' or not yet.

I basically agree with Brian on this, though Barkley you are right there's not a shred of evidence that pessimism about income prospects is tied to looming policy. Heck, the majority of households didn't know that Making Work Pay or the payroll tax cut was affecting their income, months after it went into effect. To follow up on Brian, I was able to explain about 2/3 of the decline in income expectations with state unemployment rates plus self-reported changes in personal finances and changes in house values. Unfortunately, that last third of unexplained pessimism has been pretty persistent in the recovery. Maybe that's a TGS recalibration by households, but I am skeptical...still much more plausible than the policy fears story. All that said, the formation of expectations is not well understood so there's plenty of room for debate here.

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Except that the decline in housing prices stopped some time ago and they have begun to go up in many markets, along with housing construction. The rise is certainly not enough to bring back the salad days of consumption during the bubble, but I doubt that people are still projecting forward expected further declines in the value of their houses. That is pretty much over by now.

But they're definitely not counting on future increases or spending on that basis, like in the last days of the ERA OF EXPANDING CREDIT. There's way more emphasis on prudent balance sheet management by both households and businesses then we've seen in a long time- that's what you do after a hurricane. Attitudinally, people will inch back toward risk and leverage slowly, over decades, just like in the post-war cycle, which seems right to me.

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Real rate of return, negative? Wouldn't that mean that you are better off just buying gold and sitting on it?

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I don't get the title. Don't the facts show that consumption has recovered as much as GDP, while investment lags? See, eg,


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How about a discussion of what the FED's Zero Interest Rate Policy (ZIRP) has had on the retired population. My 100K in savings was accumulted with the idea that it would produce $5000-$6000 per year in income to supplement employer retirement plans and Social Security, Now I'm lucky if I get $1500 per year which means that the FED is taking my money and giving it to someone else - banks and fund managers. So I cannot consume because I don't have the cash. There are millions more like me out here.

Oh, that is rich. Come on now, can't you buy a bank or something?

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We aren't as rich as we thought we were.

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